Monday, January 5, 2015

This space has not carried
much about, nor commented at length on, the multitude of articles and
essays on the ongoing drop in the price of petroleum; mainly because
much, perhaps most, of this has been wrong in so many ways, starting
with the misrepresentation of the supply and demand influences on the
price.

The current favorite myth
contends that the fall in the price of oil is due to the Saudis
trying to punish Russia for supporting Assad and drive the frackers
in the US out of business while also punishing the evil Shia
controlling oil in Iran and Iraq. Drivel, starting with the simple
observation that the Saudis are pumping about the same amount of oil
they have for nearly a decade and OPEC as a whole is maybe 500,000
barrels a day over it's long set target.

The US, on the other hand,
is suddenly pumping out an extra 4 or 5 million
barrels a day from fracking operations – if there is a country that
has upset the apple cart, it is the US. Telling the Saudis they have
to stop pumping oil because we want to continue is a reasonable
example of how silly most of this discussion is.

Another comment fairytale
involves the US, with Saudi help, torpedoing oil prices so as to
“punish” Putin for getting in the way of US plans for Ukraine.
Yes, the Russians did upset our neat plans for Kiev, and the low
prices are hurting Russia, but even if Vladimir was to suddenly
withdraw his support for ethnic Russians in Ukraine and give back
Crimea, how would that change the global supply and demand problem
with oil?

Even those dwelling on the
supply and demand equation mostly miss what's going on, the circular
and long term nature of the situation. And the demand side is
generally given the least discussion when it is the most important
factor. I don't need a barrel of
oil in the backyard. I don't even – at base – need the 19
gallons of gasoline or the 11 gallons of diesel hidden in a barrel of
crude. What I need is transportation – to get from there to there.
Or to move stuff from a hole in the ground to a refinery to a factory
to a store and ultimately to my house. What has diminished is not
the need, specifically, for diesel or gasoline; what has shrunk and
continues to shrink is our ability to pay to transport stuff, because
the more money we divert to pay to get the fuel,the less of
the stuff we can afford - and thus the diminished need for transport
fuel. Viola! Surplus unaffordable oil! The price of oil tells us
that economies around the world are slowing down and nearly at a
stall. [Here's where the chorus starts chanting “Be afraid. Be
afraid.”]

It is all traceable to peak
oil, back in late 2005, when the price of oil started rising, ending
in the collapse of the housing bubble and the beginning of a
desperate search for more oil – in the deep sea, in the arctic, in
tar sands and oil shales. And more was found – at ever higher
costs, both in money and energy. Note that the more energy it takes
to produce the oil, the less oil there is for other purposes like
transportation. Years of increasing amounts
of energy and money being shunted into producing petroleum has
resulted in the world-wide malaise that is settling in. What has
diminished is not the need, specifically, for diesel or JP4 or
gasoline; what has shrunk and continues to shrink is our ability to
pay to transport stuff and, because we divert ever more money to pay
for the energy to transport the stuff, the stuff itself and thus the
need to transport fuel. And suddenly we have a global surplus of
unaffordable oil!

To counter the increase in
the cost of the basic essential component of civilization, central
banks (mostly the Fed) have created trillions of dollars – first as
credit to continue the frenzy of buying stuff and then to pay for
increasingly expensive petroleum and now to fight off the deflation
and eventual depression that is surely coming our way. It will not
be brought on solely by the oil debacle; nearly every primary
extractive component of modern commerce is becoming scarcer and more
expensive to produce with concomitant increases in debt funding.

All that debt will have to
be paid back or rolled over – and most likely at higher interest
rates once the central banks begin trying to deflate the asset
bubbles they have built. And that is when the real fun will begin.
And it has little to do with an oversupply of oil and a lot to do
with a tremendous oversupply of central bank created inflationary
cash which was (and is) pumped out to offset the simple reality that
we cannot afford the ever expanding capitalist economy any more, if
we ever could.

2 comments:

For the same reasons I subscribe to the SAR blog, I appreciated this entry. The comments about oil supply, demand, and price are spot on. I've been struggling with the meaning of money as it is obviously disconnected from objective reality except in the expectations of those who "rent it out".

«Note that the more energy it takes to produce the oil, the less oil there is for other purposes like transportation.»

You already know this, but to complement: since oil revenues have financed colossal population explosions in most oil producing countries, and increases in their use of energey per capita on top, their domestic consumption of oil has boomed, and it is *net exports* that drive the internal price. Some stats for Saudi Arabia and Algeria:

«created trillions of dollars – first as credit to continue the frenzy of buying stuff and then to pay for increasingly expensive petroleum and now to fight off»

This is in the language of "aligned" Economists is called "accomodating higher commodity prices". This was done in the 70s at the time of the first oil price jump, caused by the extra demand from Japan instead of China, and the consequences of that "accomodation" were called the "wages to prices inflation spiral" when instead it was the "prices to wages" one. The "accomodation" was done to prevent the massive worker unrest that would follow a huge cut in worker standards of living if the "accomodation" was done by cutting worker pay. Nowadays the latter is easy, as in the UK where median "real" worker wages have fallen by 20-25% following the decline of Scottish oil production.

«the deflation and eventual depression»

The depression for workers, but will be inflation for many other things.

«All that debt will have to be paid back or rolled over – and most likely at higher interest rates once the central banks begin trying to deflate the asset bubbles they have built.»

It will be rolled over at very low nominal interest rates, probably fairly high relative to wages.

Central banks will never deflate the asset bubbles, because those assets are used as collateral for loans owed to financial corporations, and lower asset valuations would technically bankrupt most of the first-world's financial corporations after decades of expanding leverage ratios to chase ever higher turns of the debt-collateral spiral.

Central banks have seen the Japanese case where a collapse of bubbled up asset prices caused the technical bankruptcy of the entire Japanese financial sector and most of its industrial corporations, and the decades of wage deflation it followed, and are determined to do the same preventively.

As to politicians, as Simon Johnson wrote well in his famous Atlantic article, they always double down on unsustainable debt booms:

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